A Credit Crunch And Why It Occurs

By Contributor • Apr 21st, 2009 • Category: Credit

Credit Crunch

During the past months, the global credit crunch continues to create damage in all financial sectors across the globe. Due to this, things have become very difficult for both consumers and lenders. Lenders find it really difficult and expensive to raise money to fund their lending. But what is credit crunch?

A credit crunch is a condition of the economy in which investment capital is hard to attain. This is when banks and investors become unwilling to lend funds to corporations or have limited funds to lend. They increase the amount of borrowing which borrowers find it really unaffordable.

Credit crunch usually happens when lending firms suffered losses from previous loans they made. Due to this, they become generally hesitant or unable to lend borrowers money. Furthermore, when they recognize that the risk is high in the market, banks will raise their rates to counteract the risk. This often results to borrowers being unwilling to borrow because the rates are higher, and the banks in turn may not lend at all.

What is the effect of credit crunch to the economy? Credit crunch can cause a lot of damage to the economy. It can limit the growth of the economy because of the reduced capital liquidity and the ability of corporations to borrow money is diminished.

Borrowing money from lending institutions is necessary for a lot of companies in order to finance and expand their operations. If they can’t borrow, companies will not be able to expand and worst, they might even stop operating. And if recession takes place at the same time, many companies might end up going bankrupt.

So how can companies guard themselves when credit crunch happens? It is necessary that companies limit their spending. It also helps a lot if they control their debts. If the credit record of companies is clean, credit card companies and mortgage lenders will more likely to lend them funds.

Companies must be able to save more instead of spend a lot. The effects on their company is lessened if credit crunch happens. With so many savings, they don’t need to borrow from lending firms. Finally, it helps a lot if their investment is diversified.

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